Roughly 70% of American students end up taking out loans to go to college. Chances are you or someone in your immediate family (spouse or children) has student loan debt, which can prevent your loved ones from investing and building wealth. Therefore, one of the best gifts you can give a college graduate is money to help with their outstanding student loans. Unlike payments made directly to educational institutions for a student’s tuition payments, financial gifts to cover student loan balances can be tax-exempt. Here are some ways to help a graduate pay down student loans without incurring gift taxes.
Loan co-signers—usually a parent—can make tax free donations of any amount by making payments to the loan. There are no limits to the payments you can make as a co-signer on a student’s educational loan. You can even pay off the entire amount for the student without incurring any gift taxes. Having a co-signor for a student loan helps the graduate make smaller payments on the loan with beneficial interest rates, while having an opportunity to start investing and save for future goals like buying a house, traveling, moving, or getting married.
If you did not originally cosign the student loan and are now interested in helping pay it off, there is a way to do so without incurring the annual gift tax. This is especially useful if the original loan term had a high interest rate or high monthly payments because of the credit history of the student. If the student loan is eligible for refinancing, consider taking the opportunity to do so. Not only does adding a financially strong consignor at the refinance lead to preferential interest rates, but refinancing private and/or federal student loans with a bank, credit union or online lender consolidates the loans into one new loan, making for a simpler repayment.
Note that if you cosigned a loan for another person’s educational expenses, you’re as responsible for the debt as the student who was the recipient of the loan.
Under most loan providers and tuition plans, you can typically add yourself as an authorized third-party payer. That way, you can go directly to the source and make payments. They can also set up automatic payments to send money straight from your bank account to the loan servicer on a regular basis.
This method makes it easy to see the impact of the payments you make, both for yourself and the student loan borrower. It’s easy to print statements and see monthly loan balances, which is helpful when planning budgets and finances. If there is any paperwork or forms that you need to fill out to become an authorized third party payer (or an account number to add to your monthly automatic bill payments), they will also be available through the service website.
If your child is still in college, this is perhaps the best way to pay off student loans and tuition before they start accruing interest. You can make unlimited, tax-free gifts of educational expenses, as long as they are paid to the college, university, or postsecondary institution directly.
You can also simply write a check or gift cash to the student loan borrower so that they can make the payment themselves. While this can be a tempting option for many reasons, there is a maximum dollar amount that is tax-exempt by the IRS. In 2021, the tax-exempt gift limit set by the IRS is $15,000. Gift taxes apply only to the amount of cash you give that’s over the Internal Revenue Service’s yearly gift limit. As long as you keep your cash amount lower than the annual tax exclusion limit, your monetary gift is not subject to any gift taxes.
Note that the $15,000 limit is subject to a 12-month period. You can avoid paying the gift tax and help a graduate knock down their student debt by giving them the maximum allowable amount of non-taxable gift cash for several years in a row.
In case the gift is larger than the tax-exempt maximum, the person giving the student loan payment as a gift will be responsible for paying all applicable gifting taxes. If you’re planning to gift a sizable amount, the tax implications of your gift should be a consideration. There are annual and lifetime tax exclusions that can help to minimize those taxes, but check your state laws regarding specifications.
Under the gift tax rules of the IRS, each parent of a student is treated as an individual. As individuals, each parent may give the maximum tax-exempt amount to their child without paying any taxes on the gift.
In 2021, a couple may give $15,000 each to a graduate without paying the gift tax. Therefore, your loved one can receive up to $30,000 total in tax-free cash from both you and your spouse to help pay off their student loans.
Grandparents, aunts, uncles, and other family members are allowed to act as donors and give tax-free gifts of cash to help pay down student loans. As long as each family member gifts an amount under the maximum amount of nontaxable cash to a graduate, none of the generous family members must pay gift taxes.
If four donors give the maximum yearly amount of $15,000 to help the graduate pay down their student loans, that equals $60,000 in gift cash that incurs zero tax burden. That’s a significant amount of money to help reduce an outstanding student loan balance.
Under the unified tax credit established by the IRS, each person has a lifetime cap on the number of assets they may give to other parties before the gifts are subject to gift taxes. The unified tax credit helps people with significant assets avoid taxes on both gift and estate taxes.
In 2021, the gift and estate tax exemption applies to transferred assets up to $11.7 million in value. Talk to your accountant or tax attorney to learn more about using the unified tax credit to lower or eliminate gift tax burdens when giving cash.
Your financial professional should help you and your gift recipients stay within IRS guidelines whenever you give away assets including cash. Always consult an expert before you transfer cash to a graduate, student, creditor, or educational institution.
When giving funds to loved ones to help them pay off student debt, make sure you clarify how they can attribute the funds to pay down the principal amount of the loan. If the student loan account is in good standing, the student loan servicer can apply your gift to the loan balance. Write a letter to the servicer or look for settings in the online portal when making the payment. Make sure to keep a copy of any communication you have with the loan provider for your records. Also, encourage your loved one to check his or her monthly statements to ensure the payment was attributed properly.